Forex trading is essentially the buying of one currency and the simultaneous selling of another. Therefore when trading currencies we will always see them quoted in pairs. Forex markets usually classify currencies in three groups: major, minor and exotic currencies. Exotic currency is the term given to thinly traded currencies which are low liquid, lack popularity in terms of consistent market activity, and trade with high markup fees at select markets or dealers.
Exotic currencies don’t necessarily mean weak or undervalued currencies, but it does indicate limited and “not-so-popular” behavior in terms of trading activity. Exotic currency pairs are made up of a major currency paired with the currency of an emerging or a strong but smaller economy from a global perspective such as Hong Kong or Singapore and European countries outside of the Euro Zone. These pairs are not traded as often as the majors or minors, so often the cost of trading these pairs can be higher than the majors or minors due to the lack of liquidity in these markets.
Spreads are bigger on exotic currency rates than their majors or minors counterparts. Traders should thus apply caution when trading exotic currencies and take cognizance of the higher spread when computing their possible gains. Trading exotic currencies could vastly differ from trading majors or minors in view to the level of interest shown in the market for exotic currencies. The relative absence of activity in the market for exotic currency implies such currencies will carry an elevated risk and huge transaction cost, but with a proper strategy and the right trading personality, these pairs can be mastered.
One of the attractions of exotic currency pairs is the potential to earn interest from the trade. When you purchase an exotic currency with a high interest rate against a currency with a low rate you can earn the difference, less any fees. The risk, of course, is that the currency moves against you, even if you do earn interest, causing an overall loss. While exotic currency pairs can have high interest rates they do also tend to have higher spreads than major currencies. Check the spread before you trade, and if possible adjust your strategy to cater to this. You could do this by trading a higher time frame such as a daily or weekly chart, where spreads are less of a factor.
Forex trading is all about taking a calculated risk and it is perfectly possible to make a profit trading exotic currencies. For most traders though, sticking to the more common pairs is both easier and less dangerous in the end. Experienced market makers and dealers are usually the ones to benefit from trading exotic currencies by capitalizing on the wider spreads, at the expense of other counterparts. Forex exotics may make a good investment option for experienced long term investors, international fund managers or investors willing to add some diversification to their investments at global level.